Wednesday, February 17, 2010

The Anti-Lemons Paper is Great, Not Useless

I’ve had the effects of reputation on higher ed on my mind a lot lately, so I was intrigued to read a slew of blog postings on W. Bentley MacLeod and Miguel Urquiola’s new Anti-Lemons paper.

For those of you who haven’t read it, the basic story is as follows. M&U created a theoretical model to analyze when reputation is a sufficient incentive to yield normal market outcomes (i.e. that a free market is better than a government controlled one). They find that as long as schools cannot select their students based on ability, than doing vouchers and private schools instead of government schools is better since “competition raises average school productivity and improves learning” just as the free market story says.

However, if schools can select their students based on ability, than vouchers are no longer better than government controlled schools. The reason is that schools have an incentive to cream-skim the best students, which bolsters their reputation. This anti-lemons effect- “entry by selective schools that derive their reputation for high quality from selectivity”, in turn means that students have an incentive to go to selective schools (because employers use school reputation as a signal of employee quality), which means that once they get in to a selective school, students have less of an incentive to study.

Liberals like Matthew Yglesias tend to like the paper since one of the findings is that free markets aren’t a panacea.

I would have to pay $5 to read the whole paper, but the abstract conveniently supports political positions I like, so I’ll talk about it some more.

[AG: Don’t let the paywall stop you – just enter your old .edu email and they will send an email to that address that allows you to view the paper.]

Libertarians are more split. On the “we like the paper” side are Megan McArdle and Tyler Cowen’s GMU posse (7th comment on Yglesias’ blog).

On the “we don’t like it” side is Cato’s Andrew Coulson. Coulson was really the only one to discuss the specifics of the paper (everyone else just said “we like it”), but in contrast to his superb book Market Education, I didn’t find him convincing.

Coulson seems to have two main objections to the paper. The first is that “ ‘it’s only a model’ — and not a very good one at that”, with the reasoning being that the assumptions made are unrealistic.

Needless to say, I don’t find that a very convincing critique. I’ll reuse a quote from Paul Krugman to illustrate why:

I am a strong believer in the importance of models, which are to our minds what spear-throwers were to stone age arms: they greatly extend the power and range of our insight. In particular, I have no sympathy for those people who criticize the unrealistic simplifications of model-builders, and imagine that they achieve greater sophistication by avoiding stating their assumptions clearly. The point is to realize that economic models are metaphors, not truth. By all means express your thoughts in models, as pretty as possible (more on that below). But always remember that you may have gotten the metaphor wrong, and that someone else with a different metaphor may be seeing something that you are missing.

The last part of the quote, that the model might be missing something important, is related to Coulson’s second objection: that the predicted results are

completely at odds with the reality established by the large body of empirical findings in this field.

I’m not up to date on all the relevant studies, so this may well be true. However, even going by Coulson’s numbers in figure 2 here, we would expect to find a positive impact of markets over government on achievement in slightly less than 2 out of 3 studies (with insignificant findings making up the majority of the others). If the case for free markets over government schools is really so clear cut (and I lean strongly in this direction), than why isn't this 3 out of 3?

And here is where the usefulness of the M&U paper for Cato’s free market case comes in – it offers a convincing theoretical explanation for why free markets are only convincingly showed to be better 66% of the time. And even more importantly, if it is correct, the paper indicates how school choice programs can be structured to ensure that they make things better.